Between the Devil and the Deep Blue Sea
The dollar gyrated wildly last week as it was subjected to the full range of influences. Initially, it moved higher after an uber-hawkish appearance from Jerome Powell in front of Congress last Tuesday. It seemed that finally, the penny had dropped, and traders started to take on board the higher for longer message that the Fed has been trying to communicate for what seems like an aeon. However, with higher rates comes risk, as the Bank of England and the UK pension industry discovered earlier in the year after the rout in gilt-edged securities and the LDI debacle. With the demise of Silicon Valley Bank, questions are increasing over whether there is systemic risk being caused by high rates. Will SVB be the last bank to face problems? We hope so, but sadly, fear not.
Of course, after the issues emerged over SVB, the dollar retreated as traders started to dream of the Fed beginning to pivot. Whether there was enough in Friday’s Non-Farm Payroll to ruffle the Fed isn’t sure, but it probably pushed them away from a 50bp move towards 25bp, and after the weekend’s events with SVB, it looks certain to be 25bp. Even before SVB questions were being asked as, despite a better-than-expected headline figure, the unemployment level rose whilst wages fell short of expectations. The NFP was certainly enough to give the dollar another little nudge down, and it closed the week on a soft note which has continued this morning
There is another full data docket this week in the US, the last complete week ahead of the Fed’s next meeting on the 21st and 22nd of March. The key data from the Fed’s point of view will come tomorrow afternoon with the release of February’s Consumer Price Index, which is expected to continue to be stubbornly strong. Whether it’s good news or bad news, time will tell, but the Fed entered its blackout period last Saturday, so there are no more hints on policy this week! Also scheduled to be published are Retail Sales on Wednesday and industrial Production on Friday, both of which are seasonally affected by weather which has, to say the least, been somewhat volatile. Friday also sees the release of the Michigan sentiment indicators, including inflation takes, which have been known to move markets. Ordinarily, we would expect to say with some confidence what the Fed is likely to do next week. However, it would be prudent to keep an eye on equity markets, especially the banking sector, over the next few days to see if there are further signs of trouble ahead. If all stays calm, we would still just about root for another 25bp rise, but will they stay calm? Worthy of note, though, is that last Monday, the markets gave a 23% chance of a 50bp hike by the close of business on Wednesday, odds were up to 71% before dropping right back to only 38% on Friday! May we live in volatile times!
The ECB has been somewhat sidelined, with the US the centre of the storm last week and another full data docket ahead. This should change on Thursday when it will announce, as expected, a rise in its rates by 50bp and outline its projection of their further course. We expect a terminal rate of 4% by the end of summer, and this prospect seems more likely after the surprisingly high German CPI, 9.3%, published last Friday. The bloc’s own Consumer Price Index will be posted after the ECB council meeting. After recent comments from council members, including its chief economist Phillip Lane it is unlikely they will be derailed from their chosen course despite increasing noise from the doves in the camp. Hopefully, Madame Lagarde will communicate their thoughts better during her press conference than last month!
This week domestically in the UK, there is plenty for the markets to get their teeth into, with tomorrow’s employment data probably the most important for the pound’s direction. With the Bank of England’s next meeting just over a week away, we will be watching to see whether wage growth has started to flatline. Recent data infers that it is holding up, and if tomorrow’s figures confirm this, the pressure will grow on a seemingly reluctant Bank of England to raise rates by another 25 bp next week. We also have the little matter of the budget tomorrow. Still, with its policies well trailed, it is unlikely to hold many market-moving surprises. However, if the proposed hike in corporation tax doesn’t materialise, sterling may get a short-term bump. But ahead of the more certain rate rises by the European Central Bank, it’s hard to become too bullish on sterling against the euro, and it could have a bumpy few days ahead. The big question, of course, is whether SVB will lead to further problems in the banking system both in the US and further afield. When the central banks last had issues with bank liquidity, Lehman et al, responded by pumping funds into the markets. The Fed’s money printing (better known as QE) over the last decade to protect the financial system has caused much of the inflation they are trying to control by raising interest rates. QE has also caused many to believe that interest rates would never go up again, and institutions either looked to risky derivatives to enhance yield or adopted benign neglect. The risk of the derivative plays was first seen in the LDI issues that the Bank of England faced in September, which we flagged at the time as a possible canary in the coal mine. Now at the very time, they wish to continue to raise rates, it appears that the financial system is creaking, and the knee-jerk reaction is the expectation that they will slow rate rises and print money to rescue it. It is no exaggeration to say they are stuck between Scylla and Charybdis.